David Ceresne: Watch out when physical market for gold and silver detaches from paper

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By David Ceresne
Saturday, February 2, 2013

Shortages and volatile markets are forcing the precious metal industry into turbulent times.

How is the precious metal industry adapting? Global mints and refiners have increased premiums on all products.

How are investors reacting? Buying is at an all-time high and premiums are no longer the primary concern. In fact, delivery time on products now is the most important factor for buyers. This shift demonstrates the demand for precious metals, whatever the premium may be.

It's simple. Relentless demand and shrinking supply are changing the precious metal landscape. We are witnessing a deviance from paper price to physical price. But why?

To understand the changing landscape, we need to analyze the precious metal supply chain. Looking to global mints can let us know what changes must be made.

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To start, where are mints getting their metal? It boils down to three sources.

1) Mining companies. Above-ground and easily mineable metals are a thing of the past. Mining companies must dig deeper than ever to extract precious metals. Changing mining conditions and high input costs are affecting the precious metal supply. As mining conditions change and inflation continues to rise, the extraction of metal through mining appears to become less feasible. Political factors also play a role. Laws, politics, and tax rules can slow down or even stop the extraction of precious metals in key markets.

2) Recycled products. It is estimated that 85-95 per cent of world silver output is now disposed of, primarily through industrial applications. Middle-class people all over Europe are trading in their gold and silver for cash, disposing of everything from jewelry to silverware. In North America the story is the same. But much of that supply has already been depleted as people sell personal items to help pay the bills. This causes a big strain on the physical gold and silver markets. People are also liquidating their retirement accounts and selling assets to buy precious metals. Supply is depleting as demand increases.

3) Global trading floors. Mints and refiners will purchase silver and gold from global trading floors. If you have purchased precious metals before, many of your products may have been melted down from large bars into smaller-denominated coins and bars.

But the next time mints ask for metal to melt, will it be there? With current demand for metals, the answer is no. Then what? If there is no silver or gold to procure, we will head toward a "force majeure" (http://en.wikipedia.org/wiki/Force_majeure).

At this point the paper price will have no relevance to the physical price. As people rush for the door, dealers will undoubtedly sell. But at what price? This will be for the true markets to decide.

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David Ceresne is president of Precious Metal House (http://www.preciousmetalhouse.com/), a coin and bullion dealer in Toronto.

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